Private sector pensions are taxed more heavily than public sector schemes
Private sector workers only get half the pension they get in the public sector before facing punitive tax bills, research by Money Mail shows.
The lifelong allowance specifies how large a pension fund can be before savers have to pay tax on contributions.
It’s capped at around Â£ 1.07 million, and workers must pay a 25 percent tax liability on savings in excess of that limit – as well as customary income tax on the cash out.
Schief: Employees in the private sector only receive half the pension payments as in the public sector before they are confronted with penal tax bills
However, the tax allowance is far more damaging to workers in the private sector with simple savings in pensions than it is to those in the public sector who have salary-based arrangements known as defined benefit pensions (DB).
This is due to the outdated way the tax advisor calculates the value of salary pensions. Since the DB pensions are not just a pot full of money, HM Revenue & Customs multiplies the annual income that the system pays out by 20.
This formula was developed before the lifetime allowance was introduced in 2006 and was based on the pension rates at the time.
Annuities are insurance products that can be purchased with old-age provision and guarantee an income rate until death.
But interest rates have plummeted in recent years – savers can no longer get as much for their retirement plans.
Money Mail’s calculations show today that a 65-year-old with a Â£ 1.07 million (DC) pension pot could now secure a pension of just Â£ 25,000 a year without violating the lifetime allowance. The pension rises with inflation and would also pay the partner an income after death.
But a civil servant could get a pension of Â£ 53,000 a year with the same benefits before breaching the allowance, according to figures from financial advisor William Burrows.
In comparison, when the Lifetime Allowance was introduced 15 years ago, a retiree could buy Â£ 55,500 retirement income without being charged a tax bill.
Pension Tax: The lifetime allowance is capped at approximately Â£ 1.07 million and workers must pay a 25 percent tax on savings in excess of this limit
Salary-based savers have been able to earn Â£ 75,000 a year without breaking the allowance, which was then Â£ 1.5 million.
Tom Selby, Senior Analyst at AJ Bell, said, âThis is another example of the yawning retirement gap that exists between the private and public sectors.
“This quirk in the rules means that defined benefit members can enjoy up to double the lifetime allowance of their defined contribution colleagues.”
Burrows of the Retirement Planning Project says, “The lifelong allowance cut is affecting more and more people now, not just fat directors, but ordinary middle-class professionals and business owners as well.”
The results come after Money Mail revealed last week that public sector workers can expect to save more than Â£ 10 for Â£ 1 in their pension system, while private sector savers can only get Â£ 3.
Salary pensions are offered by large public sector employers such as the NHS or the public sector. However, they are rarely available in the private sector, where basic self-entry pensions are the norm.
The Treasury Department reportedly is considering cutting the lifetime allowance to just Â£ 800,000 in an effort to pay for a solution to the social welfare crisis and recovery from the pandemic.
Biased: The lifetime allowance is far more damaging to private sector workers with simple savings in the pension fund than it is to public sector workers with salary defined benefit arrangements
Cutting the allowance to Â£ 800,000 would give DB workers an annual pension of Â£ 40,000 and a DC saver a pension of Â£ 18,500.
Baroness (Ros) Altmann, former Minister of Pensions, says: âThe lifelong bonus never made sense. This is another example. Above all, it disadvantages people in the private sector who cannot hope to get as good a pension as in the public sector.
Baroness Altmann says the savings limit punished those in the private sector who saved hard and invested well, while those in the public sector were given generous pensions. She adds, “It’s a rule for her and one for everyone else.”
She says cutting the allowance further would be an “absolutely terrible” political decision.
Workers are now only allowed to save a maximum of Â£ 40,000 a year in their retirement before they lose the tax break. Baroness Altmann suggests that this annual flat rate should be the only restriction for development cooperation savers.
The lifetime allowance peaked at Â£ 1.8m in 2011 but was gradually reduced before hitting a low of Â£ 1m in 2016. It has now been frozen for five years.
Figures released last week show 7,130 savers exceeded the lifetime allowance in one year, 1.4 percent more than last year and HMRC paid Â£ 283 million, 5 percent more than last year.
Jamie Jenkins, Director of Policy at Royal London, said: âWhen these calculations were originally made, pension rates were higher and a pension pot of Â£ 1 million could well have resulted in a pension of close to Â£ 50,000 a year.
‘However, pension rates have come down significantly over the years and that contributed to this anomaly.
A further cut in the lifelong benefit would most likely apply to both DC and DB pensions unless the rules were changed, but this could become even more complicated for savers. ‘
Nigel Peaple, director of policy at the Pensions and Lifetime Savings Association, says the discrepancy did not have a material impact as few DC savers made the lifetime allowance.
He says, âEven so, this is another good reason why the government shouldn’t cut the lifetime allowance or even reduce the amount of tax support for retirement savings.
“Most people, especially those in defined contribution schemes, do not save enough for retirement and therefore need more support, not less.”
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